corporate value improvement ltd. 1 the art and science of creating superior returns for shareholders...

Corporate Value Improvement Ltd.

1The Art and Science of Creating Superior Returns for Shareholders © Corporate Value Improvement Ltd

170603 SGSB MBA Elective 1st July

2003

Challenges and Choices for the Top Team in Relation to Shareholder Value

Hilary Collins




2003

Challenges and choices for the top team related to shareholder value

Making trade-off decisions (now vs future; where to allocate resources; etc)

What are the objectives of the business?

What drives the value of the business?

What levels of performance do want to deliver and how will we measure that performance?

How will we set targets for parts of the company and for key individuals?

How should we measure and manage financial performance?

How should we think about strategy?

What do we want managers to focus on now?

How should we solve the problems and grasp the opportunities we face?

How should we take big decisions?

How should we structure the business?

How should we allocate roles and responsibilities to senior managers?

What management information is needed?

How will that be delivered?

How do we develop the management capabilities and motivation needed to deliver superior returns to shareholders?

How do we get the organisation to work together at different levels?

InfrastructureObjectives and

Targets

Financial and strategic visibility and performance

Focus, Agendas, Business

Cases, and Decisions

People and Alignment




2003

The horse will run as fast as it’s slowest leg allows

CVI Business Framework

Objectives and Targets


Focus, Agendas, Business Cases, and Decisions

Infrastructure





2003

What is “managing for value”?

A distinctive approach to managing businesses

“We are in business to maximise the returns to our shareholders over time”

Consequences for:

“The way we do things around here”

1. We set and use performance aspirations and targets based on measures that are relevant to our shareholders

2. We strive to get and use good visibility of the locations and sources of value creation and destruction in various ways across our business.

3. We focus our managers on the issues and opportunities that will have the biggest impact on the value of the business

4. We align the work of managers at different levels and in different parts of the business with shareholder value

5. We create robust value-based business cases to help us to take the big decisions

6. We equip and motivate our organisation to manage for value

7. We develop value-based managers

“Lloyds was a VBM pioneer in the mid-1980s and went on to create huge value for its shareholders. Indeed, its share price doubled every three years for about 15 years. Chairman Brian Pitman has no doubt where the credit lies: “Doubling the share price every three years can’t be accomplished by incremental change; it requires major change and scrapping the old ways of doing things...Managing for Shareholder Value (Lloyds VBM programme) was the driving force behind our success”




2003

• “The Wealth of Nations”...

• Late 1970’s– “We measure, therefore we know”– MFV = valuation using

discounted cash flow techniques

• The 1980’s and 90’s– “Strategy drives financial performance”– MFV = strategy from a value

perspective

• 2000 – – “The whole business needs to be aligned

with value”– MFV = holistic approach to

management focused on shareholder value

• MFV as a concept has been around since Adam Smith

• But it has been operationalised only in the last 20 years

• There are very few businesses (and even fewer consultancies) which have a good understanding of how to operationalise MFV

• MFV is a rigorous and systematic management discipline which often requires decisions to be made which are seemingly at odds with “traditional” management thinking

• The number of MFV exemplars has been small but it is growing rapidly, especially in the Anglo-Saxon area

The development of MFV over time

Overview of Managing For Value (MFV)




2003

Some well-known businesses have attempted to become value-based (in various ways)

Many industries; USA/UK predominance (up to now)

Entertainment Disney

Beverages Coca-ColaCadbury SchweppesDiageo

Information ReutersBT

Banking Lloyds TSBBank of AmericaBank of MontrealABN AmroStandard CharteredBarclaysHSBC

Insurance Prudential

Chemicals Dow ChemicalBP

Manufacturing BoeingChampionGEAlcanAmcor

Retailing Boots GroupColes MyerNordstromJ SainsburyAholdMetro

Pharmaceuticals Roche

Property Slough EstatesServices Centrica




2003

Market Value Added

The wealth that has been created or destroyed by management since the start of the company

Financial TimesFinancial Times

UK plc

number of shares (2bn)

xthe share price

(£5)=

the “market capitalisation”

(£10bn) The money that investors (and managers) have

invested (reinvested) in the business since it started

(£7bn)

The money that investors (and managers) have

invested (reinvested) in the business since it started

(£7bn)

MVA - any value that managers have created (above and beyond the money which has been

invested)(£3bn)

MVA - any value that managers have created (above and beyond the money which has been

invested)(£3bn)

MVA represents the current speed of the “Management

treadmill”

Shareholder value: key external performance metric 1

Market Value Added (MVA) represents wealth created (or destroyed) since the founding of the company

Book

Market




2003

= Share Price Appreciation plus Dividend Yield

Total Shareholder Returns (TSR) =

(Share Price(eoy) - Share Price(boy)) + Dividends per share

Share Price(boy)

Shareholders

TSR represents the speeding up or slowing down of the “Management

treadmill”

• Share prices are driven by investors’ expectations of future cash flows (or economic profits)

• “Meet expectations” = deliver cost of equity capital (ke): share price stable : MVA = 0

• “Positive surprises”: share price rises: increase in MVA

• “Negative surprises”: share price falls: decrease MVA

• Short-term results (positive or negative surprises) change expectations of future performance and can result in large swings in share prices

• Investor expectations need to be managed very carefully

• But financial performance is the only thing that matters in the longer term

Shareholder value: key external performance metric 2

Total Shareholder Returns (TSR) is an annual measure of return to shareholders




2003

CEOs are coming under increasing pressure to deliver TSR performance, especially in Europe and Japan

CEO’s who do not deliver superior TSR’s are being fired both more often and faster than before

* “CEO Succession 2002 – Deliver or Depart” Booz Allen Hamilton, strategy+business magazine, summer 2003

The 2500 largest quoted companies worldwide were

studied. In these companies, 253 CEO’s retired, died or

got fired in 2002

39% of these CEO departures appear to be “firings”

caused by unacceptable performance, up from 25% in

2001

CEO’s who were dismissed in 2002 had generated

median shareholder returns 6.2 percentage points

lower than those generated by CEOs who retired

voluntarily

“Failing” CEO’s seem to be getting fired sooner




2003

Challenges and choices for The Top Team

How can you get consensus around the right Governing Objective?

Do we have consensus on what drives the value of the Group on the stock market?

What is the governing objective for the Group?

• What are we trying to maximise?

• How do we trade-off competing objectives when we make big decisions?

What is our performance aspiration for the Group?

• Relative to a set of competitors or an index?

• Other?

What terms should we use to express that aspiration?

What financial performance over time is likely to be required to meet this aspiration?

Is there a gap between this level of performance and our current forecasts?

How do we cascade our performance targets in ways that are meaningful for the main operating companies and then further down to line managers?

Do our KPIs match well with the drivers of Group value? Have the KPIs been cascaded appropriately?

InfrastructureObjectives

and Targets

Financial and strategic

visibility and performance

Focus, agendas, business

cases and decisions

People and alignment


Targets








2003

Executives are subjected to pressure from many other stakeholders

How should the trade-offs be made?

Banks(and advisors)

Shareholders (large and small)

Government

Personalneeds

Customers Employees and unions

Analysts and the media

Environmental groups Suppliers


and Targets




cases and decisions





2003

And internal functional priorities and preferences often conflict with each other as well

An illustration...

Sales

“Maximise revenue growth”

Marketing

“Maximise market profile and awareness”

R&D

“Maximise the technical differentiation of our products”

Production

“Lowest cost of production”

Purchasing

“Minimise the cost of purchased goods and services”

Logistics

“Maximise availability of product with lowest stockholding” IT

“”Do what our users want/need”

“Do the sexy stuff”

Finance

“Cost cutting”


and Targets




cases and decisions





2003

Management Behaviour, Decisions and Business Models

The decisions managers take about where and how to compete in order to achieve the performance goals

Governing Objective

The “objective function” of the Group and each business unit - the primary decision criterion

The type and level of performance goals which are used to direct managers towards achieving the governing objective

Performance Goals and Targets

Market share objectives Market share goals and targets Market share-driven behaviour and

business models

“Profit” objectives “Profit” goals and targets“Profit”–driven behaviour and business

models

Multiple objectives Multiple goals and targets Confused behaviour and business

models

Shareholder Value objective Shareholder Value goals and

targets

Shareholder Value-driven behaviour

and business models

Businesses need a clear Governing Objective to guide decision-making

The Governing Objective dictates goals, targets, management decisions and performance


and Targets




cases and decisions





2003

“Maximise value over time” is the best Governing Objective for all stakeholders

It is the only Governing Objective that facilitates decision-making which is forced to consider the impact on all stakeholders

• Companies must balance the interests of its stakeholder groups (employees, customers, community and shareholders) to maximise value over time

• Company profitability is directly linked to whether or not it has an advantage over competitors on its offer; its economic costs; and/or its pricing

• Therefore, the intent of a company which maximises its value has to be to treat its employees, customers, and community in a manner that improves its relative competitive advantage

• And value maximisation is unlikely to be sustained if a company chooses strategies, organisational structures, or decision-making processes that:

• cause the customers’ perceptions of the company and its offer to deteriorate over time

• cause the company’s relationship with employees and the community to weaken over time

• diminishes the attractiveness of its offer to customers over time

• incur excessive costs relative to competitors over time

• So our view is that “maximise value over time” is a win-win game for all stakeholders over time – increments to total welfare can only come from creating wealth

Revenue Customers

Stakeholder

- COGS Suppliers

- Wages Employees

- Overheads Employees and Suppliers

- Interest Providers of debt

- Tax Government/community

- leaves if there is anything left!

- funds for shareholders

“Maximise value over time” is what the owners of most – if not all - publicly-quoted businesses are paying their managers to do.


and Targets




cases and decisions





2003

Customer Satisfaction

Charge for Capital

Highly Profitable Customer Group

Typical Customer Group

Unprofitable Customer Group

NOPAT Financial Objectives Maximizing earnings or eps growth Minimizing total cost Stabilizing earnings over a cycle

While achieving these objectives may be consistent with maximising value, pursuing any one as the primary objective is unlikely to maximise value over time

Strategic Objectives Maximizing market share Maximizing customer satisfaction Building brand equity

Organizational Objectives Maximizing company size Balancing “stakeholder” interests

Competing Governing Objectives are sometimes adopted either explicitly or implicitly

Other Governing Objectives may or may not be well aligned with maximising value

Misguided view of customer satisfaction vs profit


and Targets




cases and decisions





2003

Discounted cash flow focus (“more recent”)

• Based on economic measures and conventions using cash flow

• Or using other metrics such as Economic Profit; Cash Value Added; etc

• Demands good forecasts of future performance

The value of the business is driven over time by the market’s expectations for the future cash flows (or EP’s) the business will generate which are discounted back to the present at a cost of capital.

Therefore, managers need to focus on finding and implementing the strategies that will maximise the NPV of cash flows or EP’s. In addition, they should find ways of reducing the cost of capital.

Earnings focus (“history”)

• Based on accounting measures and conventions

• Earnings; EBIT; EBITDA; P?E ratio

• Earnings are not the same as cash flow

• Easy to manipulate

• Excludes capital and it’s costs

• Excludes risk

• Excludes time value of money

The value of the business is driven over time by the market taking the current earnings per share (EPS) for the business and multiplying that by a P/E ratio which is based on market expectations of the future growth and quality of those earnings

Therefore, managers should focus on finding and implementing the strategies that will maximise earnings and earnings growth.

Return on Assets focus (“1980’s on)

• Emphasised the use of return metrics such as ROI, ROE, RONA, ROCE

• Same issues as Earnings, plus calculation of capital base

• Excludes growth - can stunt value creation

There is an emerging awareness of the need to use capital effectively. Ratios such as return on assets are used to take some account of capital. However, the measures that underpin decisions are still based on the accounting paradigm. Managers are driven to hit target (or hurdle) rates of return

Managers’ views on the financial drivers of shareholder value have changed over time

These changes have also changed the focus of – and priorities for – line managers over time


and Targets




cases and decisions





2003

1. Group sets out Value Goals (eg double value in 5 years;or position in the peer group)

2. Group figures out the financial performance likely to be needed to achieve the Value Goals (stream of EP into the future)

3. Group cascades the Value Goal requirements (EP over time) down into the OpCos eg:• top down: "share the pain out" based on sales revenue; or EP; or assets employed; or

some such algorithm• "share the pain out" based on top management judgement• bottom up: careful consideration of Market Economics and Relative Competitive

Position for each OpCo; plus consideration of the likely impact of each strategic management agenda

• a combination of the above

4. Why cascade? • Because the value of the Group is the sum of the value of its current OpCos• And the Group needs to calibrate each OpCo on the amount of stretch in performance

it needs to achieve to contribute to Group aspirations• which means that each OpCo needs to have the right Issues on Agendas, etc

5. What then?• Each OpCo reviews its issues/strategy in the light of their share of the Value Goals• They rework their issues/agendas in an attempt to reach these goals• When they are convinced (and the Group CEO is convinced) that the value-maximising

actions are being taken then these actions form the core of the business plan and set the performance targets against which performance is monitored

6. If there is a gap between the Group Value Goal and the sum of the OpCo performance targets (and there probably will be such a gap) then:

• the OpCos are asked to look again at their issues/agendas (although his runs the risk of becoming unrealistic if the earlier work on issues/agendas has been done well) and/or

• the Group has to find ways of plugging the gap by changing the portfolio of OpCos

Setting performance targets

A value-based approach to setting and cascading aspirations and targets




2003

External Measures

• TSRs relative to a peer set of companies

• Time to double shareholder value

Financial Targets

• Growth of EP over time

• Growth of revenue and capital

• ROC or ROE

• ECF or TCCF

Strategic Targets

• Market share

• Like-for-like growth

• Price position

• CBR or CSI

• Economic cost position

Organisational Targets

• Market share

• Like-for-like growth

• Price position

• CBR or CSI

• Economic cost position

Calibrating managerial expectations….

Internal proxies for external measures

Aligning external aspirations with internal targets

The linkage between external measures of shareholder value creation and internal measures of performance




2003

Challenges and choices for the Top Team

We can manage only what we can see and understand

Organisation and People Objectives and TargetsFinancial and strategic


Focus and AlignmentBusiness Cases and

Decisions

Which financial measures will give us comfort in understanding where value is (and is likely to be) created and destroyed in the business?

• Measures that include all the costs of doing business

• Measures that recognize the particular nature of the property business (asset revaluations etc)

• Measures that our managers can use to improve decision-making

How should we understand “strategy” from a value perspective:

• Common, value-based frameworks?

• Common, value-based language and terminology?

• Information and expertise?

Understanding the “where's” and “whys” of value creation and destruction:

• Customers?

• Competitors?

• Asset types?

• Geographies?

• Other?

Understanding and prioritising the key issues and opportunities we face


and Targets




cases and decisions





2003

Financial TimesFinancial Times

Britain plc

number of shares (2m)

xthe share price (£5)

=the “market

capitalisation” (£10m)

Stock market view

Any value that managers have

created (above and beyond the money

which has been invested) (£3m)

Any value that managers have

created (above and beyond the money

which has been invested) (£3m)

Shareowner view

Market Value Added (MVA)

This what the owners of the business want managers to

maximiseEP(£)

time

The best proxy for this is the

future stream of cash flow or

Economic Profit; including a

terminal value; discounted back

to today

Market Value Added(MVA)

Market Value Added(MVA)

Financial visibility and performance (“where value is created and destroyed”)

MVA (represented by EP over time) is the best internal proxy for shareholder value

The money that investors (and

managers) have invested (reinvested)

in the business since it started(£7m)

The money that investors (and

managers) have invested (reinvested)

in the business since it started(£7m)


and Targets




cases and decisions





2003

• Creating strategic insights

• Making strategic choices

• Targeting, measuring and rewarding realised performance

• Reinforcing the Governing Objective

• Yes

• Yes

• No

• Yes

• Yes

• No

• Yes

• Yes

Uses of Financial Measures

Economic profit over time (Market Value Added)

Annual value creation(Economic profit)

• Yes

• No

• Yes• (Group-level only)

• Yes• (Group-level only)

Total shareholder returns (TSR)

Financial measures should be thought of (like pay) as a way of communicating with managers about what matters…

Value-based businesses use three main value-based financial measures (on top of other financial measures needed to manage the business)

Shareholder value: key internal performance metric


and Targets




cases and decisions





2003

Net Operating Profit After Tax

(NOPAT)

A charge for capital

EconomicProfit

• NOPAT factors in all expenses, including deductions for taxes and depreciation (which are both genuine costs that have to be managed) in order to provide a complete picture of operating profitability

• NOPAT = EBIT x (1 - tax rate)

• Capital charge is the minimal acceptable returns that both debt holders and shareholders expect to earn from the company on their investment

PROFIT & LOSS ITEMS

BALANCE SHEET ITEMS

minus

Economic Profit includes all the costs of doing business

EP combines information from the P&L and the Balance Sheet

It can be used across the business in many ways, for example:

– It can be used to understand where value has been created or destroyed in a single period so that managers can take appropriate decisions:

• by business• by business unit (eg Value Centre)• by geography• by asset type, size or age• by product category• by product• by customer or customer segment• by supplier

– It can be used to show managers where we are experience “good growth” and “bad growth” so that they can take appropriate decisions

– It can be used to set single- and multi-period targets for performance (where the period is often a year)

– It can be used to reward managers for achieving single-period performance


and Targets




cases and decisions





2003

Operatingprofitper unit.

Units

Economicprofitper unit

Units

• Signal to management:• most of the business is profitable

• products/segments• sq. ft

• we have a growth issue• most growth is good

• Impact on management behaviour:• search for growth dominates decisions

• Signal to management:• most of the business is unprofitable

• products/segments• sq. ft

• we have growth issues and profitability issues and we know where they are

• Impact on management behaviour:• search for growth dominates some decisions• search for profitability improvement

dominates other decisions

Economic Profit can give very different signals to management

EP is not the same as Operating Profit


and Targets




cases and decisions





2003

Market valueof equity

(market capitalisation)

MarketCapitalisation

Book valueof equity

Equity market value added(MVA)

Equity Capital Invested Market value added

Book value of equity, as shown in the accounts, plus some adjustments for things like allowances for bad debts, amortisation of goodwill, and amortisation of R & D

Warranted MVA (ie in the grounded judgement of managers) is what managers should be seeking to grow and maximise

And they should do this by taking decisions which maximise the NPV of the future stream of Economic Profits

Warranted equity value

(WEV)

ΔEP

EP

ΔMVA

MVA TSR

TSR

Internal Measure External Measure External Measure


Re-cap




2003

gke

EPTVwhere

ke

TVEP

ke

EP

ke

EP

ke

EP

ke

EPMVA

665

654

43

32

21

1

)1()1()1()1()1(

EP

Time

Terminal Value (TV)

The best proxyfor

MVA is thefuture stream

of EP(including a

terminal value)discounted back to

today at thecost of capital

TV = terminal value (calculated as a perpetuity)

ke = the cost of equity capital

g = growth rate in perpetuity

)()( 6 IRROICgwhere

NOPAT

assetsnetassetsnetratioInvestmentIR eoyboy

tttt investedCapitalWACCROICEP )(


MVA and EP over time




2003

0

EP Segment B

Segment A

Investment

Customer Pressure

RegulatoryPressure

DirectCompetitio

n

MarketGrowth

SupplierPressure

IndirectCompetitio

n

Threat ofEntry

Profitable

Unprofitable

Disadvantaged Advantaged

Segment B

Segment A

Relative Competitive Position

Market Economics

Valuedestruction

Valuecreation

Participation strategy – decisions about where to compete

Competitive strategy – decisions about how to compete

RelativeDifferentiation

Position

RelativePrice

Position

RelativeEconomic Cost

Position

Business model(s)

RelativeCompetences

Strategy.........................linked to.......................Finance

Strategic insights (“why value is created and destroyed”)

Value is a consequence o of market economics and our relative competitive position in those markets


and Targets




cases and decisions





2003

• The Governing Objective is to

maximise shareholder value at al;l

points in time; not to grow market

share; to maximise EPS; to

maximise revenue, etc

• Maximising top line or bottom line

growth may or may not be

consistent with the objective of

maximising value

• Managing to maximise value

means that managers need to able

to identify and implement “good

growth” strategies and to be

effective in eliminating “bad

growth” strategies at all levels

* from: “The Value Imperative”

General Electric

(Good Growth)

General Motors

(Bad Growth)

1

$13.7bn

5%

125%

$47.0bn

21%

$13.4bn

(6%)

126%

$6.7bn

11%

*US market average was 18%

Average EP as a % of Capital

Sales Growth

Change in Market Value

Annual Shareholder Returns*

Change in investment (1981 - 1990)

Illustration*

Managers need to differentiate between ”good” and “bad” growth

WalMartEP $30m $528mMVA $664m $28.3bnGross margin 23% 23%

KmartEP -$43m -$172mMVA -$505m -$1.3bnGross margin 28% 28%

1980 1990


and Targets




cases and decisions


Managing the growth/return trade-off




2003

ke 7.2%WACC 6.5%Capital £4bn

1% more growth, or1% more return?

Value = (perpetuity)

EP Capital*(ROI - WACC)

(Ke - g) (Ke - g)=

3% 4% 5%

7%

8% £1.9 bn

9%ROI

Growth in capital

3% 4% 5%

35%

36% £37 bn

37%ROI

Growth in capital

High-return business Low-return business

Managing the growth/return trade-off The value-maximising answer may not be obvious (and may may not align well with company “legend”) – it depends on the

starting point


and Targets




cases and decisions





2003

3% 4% 5%

35%

36% £37bn

37%

ROI

Growth in capital

£27bn £36bn £52bn

£28bn £54bn

£29bn £38bn £55bn

For high-return business, trade-offtypically favours growth

High-return business Low-return business

3% 4% 5%

7%

8% £1.9bn

9%

ROI

Growth in capital

£0.5bn £0.6bn £0.9bn

£1.4bn £2.7bn

£2.4bn £3.1bn £4.5bn

For low-return business, trade-offtypically favours return

Managing the growth/return trade-off The value-maximising answer may not be obvious (and may may not align well with company “legend”) – it depends on the

starting point


and Targets




cases and decisions





2003

Strategic Threats Agenda A Strategic Threat is one that will cause an unwanted reduction in Market Economics and/or a deterioration in our Relative Competitive

Position

Customer Pressure

RegulatoryPressure

DirectCompetition

MarketGrowth

SupplierPressure

IndirectCompetition

Threat ofEntry

Profitable

Unprofitable

Disadvantaged Advantaged

Relative Competitive Position

Market Economics

Valuedestruction

Valuecreation

Participation strategy – decisions about where to compete

Competitive strategy – decisions about how to compete

RelativeDifferentiation

Position

RelativePrice

Position

RelativeEconomic Cost

Position

Business model(s)

RelativeCompetences

Arrival of a new competitor

Individual customers taking a very large proportion of output

Market growth declining or contracting

Suppliers consolidating

New technologies emerging

Entry barriers dropping

Government becoming activist

Offer becoming less attractive or differentiated (CBR falling)

Lower-cost competitors fighting on price

Economic costs rising faster than competitors

Illustrations of potential Strategic Threats


and Targets




cases and decisions





2003


Applying our efforts and resources in the right places

What are our current priorities at Group level?

What are our current priorities at Operating Company level?

What are our current priorities at function level?

How far down into the business do we want to drive these agendas?

Who is leading the charge on each of these opportunities and threats?

What is the best way for us to go about producing value-based business cases and applying an activist approach to decision-making?

Methodology?

Tools?

Decision-making process?


and Targets




cases and decisions



Targets








2003

Opportunities and threats











Focusing managers

“Management Agendas” are the priorities for action for senior managers – these agendas develop and evolve over time

Profitable Growth Agenda

1. Developing and delivering the highest value-at-stake Profitable Growth opportunities:

• A limitless appetite for profitable growth

• Profitable = returns greater than the cost of capital

• Profitable = NPV of future EP or cash flows >0

Strategic Threats Agenda

2. Identifying and dealing with the highest value-at-stake strategic threats facing the business:

• No appetite for unprofitable growth and value destruction

• Threats: falling Market Economics and/or deteriorating Relative Competitive Position

Strategic and Financial Insights

Criteria for inclusion• High value at stake• Management control• Timing


and Targets




cases and decisions





2003

The Top Team is helped to develop CVI Business Cases to resolve each issue on the two agendas

Factbase InsightsCreation of alternatives

Learning, synthesis, and evaluation

Alternative approaches to implementation

Performance commitments;

resource requirements;

PIR

The where and why of value creation and destruction

Financial analysis

Strategic analysis

Business insights drawn from the factbase

Fundamental issues and opportunities identified and prioritised

“Diseases not symptoms”

“Maximise” requires choosing from alternatives

Alternatives evaluated using forecasts with robust assumptions

Key learning points identified

Synthesis of the value-maximising alternative

Alternative approaches to implementation developed and evaluated

Implementation plan or contract created based on performance commitments and resource requirements

Strategic, operational, and financial milestones set

Post Implementation Review mechanism specified

Analysis Creativity Creativity PlanningAnalysis Analysis

Opportunities for “activist” decision-making

CVI Business Cases


and Targets




cases and decisions





2003

1. Correct timing being used?

• “Why now”?

2. Fact-based approach adopted

• “What do we need to know”?

3. Insights generated?

• “What’s new”?

• “Analysis/judgement/intuition”?

4. Fundamental issue(s) identified

• “Diseases not symptoms”

5. Alternatives-based solutions created and appropriate?

• “Not just the old favourites”?

6. Value-maximising alternative proposed and selected?

• “Objective evaluation”?

7. Implementation plan clear and feasible?

• “The best way to go about this…..who, what, when”?

Value-based criteria for effective decision-making

Criteria; and attributes of effective decision0making in a managing for value environment

1. A continuous process• Decision-making is

recognised as a continuous and on-going process

2. A systematic value-based approach• A “facts /issues

/alternatives /evaluation /implementation” approach is used to take important decisions

3. Focussed and prioritised management

• Management decisions are focussed on the highest value-at-stake issues and opportunities facing the business

4. Decisions and priorities aligned up and down the organisation

• Management Agendas are used to structure issues and opportunities according to their particular characteristics and to ensure that different levels of management are aligned in their priorities and efforts

5. Activist decision-making• Senior managers take an

activist role in taking decisions on the highest value-at-stake issues and opportunities at several stages during their resolution

6. Systematic decision-making• Decision Dialogues are the

events at which senior managers become activist in decision-making

7. High-quality decision-making• Specific criteria are used to

communicate the quality standards expected of decisions


and Targets




cases and decisions





2003


What is the best way for us to go about producing the managerial capabilities needed to deliver superior returns to shareholders?

How should we align the priorities of managers at different levels in the business?


and Targets




cases and decisions



Targets





The skill and will to manage for value




2003

“Managing for value is more about the people than about the numbers”

– continuous upgrading of people capabilities

John Sunderland, Group CEO

People in value-based companies

Cadbury Schweppes perspective




2003

Management skill and capability to manage for shareholder value

Typical changes that are required

Ambition

Accountability

Capabilities

Last years performance plus whatever small increment I can get away with

A cog in the wheel

Building/protecting functional expertise

We can be the best in the world

I am on the hook

General Manager

From... To...

Set objectives; let them figure out how to achieve the objectives; monitor rigorously

Frequent decisions. Check appropriate analysis has been carried out

Mentor, facilitator, standard-setter

Set broad goals and high standards

Micro-managed

Big decisions, check everything has been analysed

Commander, policeman

Lots of targets in lots of detail

Implementation

Decisions

Leadership

Performance


and Targets




cases and decisions





2003

Types of capability needed

• Specifying and creating the FACTBASE

• Developing INSIGHTS

• Setting stretching GOALS

• Identifying and prioritising the ISSUES

• Producing innovative ALTERNATIVES

• Objective EVALUATION of alternatives

• Disciplined PLANNING of implementation

• Ongoing MANAGEMENT of

implementation and short-term

performance

Elements of value-based decision-making

Being able to apply the MFV framework and the related analytical tools and

techniques (Knowledge)

Being able to produce insights and then to prioritise issues from the

factbase (Interpretation/synthesis)

Being able to communicate complex value-based information effectively

(Communication)

Understanding and using high standards of decision-making (Decision-

making/Standards)

Being able to produce innovative alternative ways of resolving issues

(Innovation)

Using sound judgement in setting stretching goals (Judgement/ambition)


Developing value-based General Managers




2003

• Factual, rigorous, analytical

• Ambitious, pragmatic

• Rounded, experienced, imaginative

• Innovative, open

• Risk-taking

• Persuasive, articulate

• Delegating, training

• Disciplined, demanding, accountable

Being able to apply the MFV framework and the related analytical

tools and techniques (Knowledge)

Being able to produce insights and then to prioritise issues

from the factbase (Interpretation/synthesis)

Being able to communicate complex value-based

information effectively (Communication)

Understanding and using high standards of decision-making

(Decision-making/Standards)

Being able to produce innovative alternative ways of resolving

issues (Innovation)

Using sound judgement in setting stretching goals

(Judgement/ambition)


Developing value-based General Managers

Desired attributes




2003

Incentive compensation schemes (rules, metrics)

The way we set targets for incentive compensation schemes

What managers do to achieve the incentive targets

Management focus and decisions

Market share metrics

Earnings metrics

Confused metrics

Market share-based decisions

Earnings-based decisions

Confused decisions

Shareholder Value-based behaviour and decisions

Shareholder Value metrics(Economic Profit, MVA, TSR)

• To communicate the Governing Objective

to managers (again)

• To align management and shareholder

interests by giving managers the

motivation to choose strategies and take

decisions that maximise shareholder

wealth

• To provide sufficient incentive - as

measured by the relativity of fixed and

variable rewards - to motivate managers to

apply their time and energy; to take

considered risks; and to make necessary

but occasionally unpalatable decisions

• To retain the services of valued managers

over time

• To keep costs to shareholders of

management reward at reasonable levels

Management reward in value-based companies

Objectives




2003

• Pay for increasing EP

– EP needs to be measured at levels which the employee can affect

• No threshold or caps

– but bonuses can be negative if EP falls

• A target bonus

– based on peer companies compensation

– probably larger than conventional target bonuses because there is potential for downside in EP bonuses

• A bonus bank

– to limit swings in bonus

– to ensure that bonuses re;ate to sustainable improvements in shareholder value

– to permit negative bonuses

• Performance targets set by formula, not by negotiation

– typical formula is to pay target bonus for prior years EP

– formula often forecasts EP improvement per year for 5 years

– but the base to which the expected improvement is added is reset each year based on actual experience

Management reward in value-based companies

Principles

Boots

The Long Term bonus scheme for executive directors is based on the company’s TSR performance relative to a peer group of ten retail and FMCG companies over a four year cycle. The bonus is paid on a sliding scale if Boots achieves a level of eighth or above in the peer group.

Cadbury Schweppes (1999 Annual Report)

Directors: Annual incentive based on growth in EP (target is 60% of base, rising to 90% (paid 59% and 64% in 1998 and 1999). LTIP: 3-to-6 year cycle; up to 100% of base vs weighted average TSR of a peer group (not listed) Two awards: 1. TSR - No award for mid-peer group performance; full award for 80th percentile; 2. EPS - award paid if EPS > inflation + 4%

Tesco

Tesco states that its Long Term bonus is based on a number of measures including comparative TSR performance against peer companies. No other details are disclosed.

Kingfisher

The Long Term bonus scheme for executive directors and certain other senior managers is based on TSR performance relative to a peer group of fifteen retail companies over a three year period. A bonus is paid on a sliding scale for performance in the top half of the peer group.




2003

Value Centre 1 Value Centre 2 Value Centre 3

PMUs PMUsSupportCentres

SharedServices

PMUs

BU

Value CentreAgendas

PMUAgendas

Whichdrive

Whichdrive

The BU strategy is driven by the BU management agendas

“Management Agendas” align management priorities up and down the business

“Management Agendas” drive the strategies of the business and its key components in a coordinated and systematic way

Group




2003


The organisational and personal skill and will to manage for value

Organisation structure

• Clarify who is accountable for managing the value of the business

Roles and responsibilities

• Best decision-making process

• Personal responsibility for value

Management information

• Provision

• Use

Organisation and People




Focs and Alignment

Business Cases and Decisions


and Targets




cases and decisions



Targets








2003

Value centres– the level at which the CEO manages the value of

the Group (using Dialogues)– the smallest units that have - or could have -

essentially independent strategies, with their “own” cash flows and economic profits

– Group manages the portfolio of Value Centres and makes trade-offs between Value Centres

Product market units– sub-units of a Value Centre with separate

groupings of products or customers or both– units which have significant interdependencies

with other PMUs in the Value Centre– units with no significant interdependency with any

unit outside the Value Centre– Value Centres make trade-offs between the PMUs

which they control

Support centres– Cost Centres are often created by the Group to

provide economy of scale, or to retain particular competences in-house

– units which have no independent strategy - they exist to serve Value Centres and PMUs

– units which usually do not sell their services outside the Group

– units which have economic cost targets rather than economic profit targets

Group CEO

Chairman

Value Centre Value Centre Value Centre

PMU PMU

Support Centre

Organisation structure: building blocks

The key objective of organisation structure is to maximise the clarity of accountability for managing the value of the business




2003

Administration map(How we choose to organise ourselves - structure,

roles, responsibilities, etc)

Decision-making map(How and where we make decisions)

Economic map(Where and why value is created and destroyed)

Objectives of structure

• Structure should facilitate the use of the best decision processes so we create and implement the best strategies

(right process)

• Structure should make it clear where opportunities to create value are to be found in the business

(right boundaries)

• Structure should maximise clarity of responsibility and accountability for managing the value of the business

(right accountability)

Three structural “maps”


Three “maps” of organisation structure help us to think through the best way to structure the business




2003

• We begin to identify the economic map by considering how much sharing takes place between current organisational units:– sharing of customers (internal and

external)– sharing of assets– sharing of the brand (as a particular

type of asset)

• Little or no sharing:– may well be a Value Centre

• Limited sharing– may well be a PMU

• Significant sharing– may well be a Cost Centre






Economic map – how much “sharing” takes place?




2003

Strategy decisions Participation (where to compete) Competitive (how to compete)

Resource allocation decisionsPeople and money

Performance management decisionsGoal settingAgreeing targets and measuresMonitoring and managing delivery of performance






Decision-making map – where is the best place to take decisions?




2003

• Each Value Centre, PMU, or Cost Centre has only one Manager assigned and accountable

• But a Manager can be responsible for more than one Value Centre, PMU, or Cost Centre

• Line role/responsibility• Company leader role/responsibility

Group CEO

Chairman

Value Centre Value CentreValue Centre

PMU PMU Support Centre

Stock market Other external audiences






Administration map – who is “on the hook” for delivery of performance?




2003

• Focus on businesses, not

functions

• Maximum clarity of

accountability for value

• Push decisions close to

the customer

• Process drives strategy

drives structure

• Focus on delivering EP

Structure

Organise around

businesses, not

functions

Clear roles and

responsibilities

Profit centres at lower

levels

Structure lets us use

the best process

No wiggle room on

value creation and

destruction

Decision Processes

Dialogues with

businesses, not functions

Performance measured

often

Clear understanding

about who decides what

and how

Group sets process and

standards

Zero tolerance for value

creation and destruction

Information

Info. tailored to BU needs

Performance measured

often

More info. At lower levels

Info supports the best

process

Info a “corporate

resource” :EP widely

available

People

Focus on General Managers

Performance accountable

managers

Expertise at lower levels

Selected and developed

based on strategy

Short-term and long-term

focus

Infrastructure

Some key principles; and implications for managers

Organisation and People




Focus and Alignment

Business Cases and Decision


and Targets




cases and decisions





2003

1. Creating the best conditions for value creation

– Governing objective and performance

goals

– Policies and standards

– Cultural norms and values

– External and internal communication of

Group strategy, values, and performance

2. Creating the best organisation for value creation

– Organisation structure

– Roles and responsibilities for managing

value

– Decision-making processes and standards

– Management information

– Motivated and capable people

3. Ensuring that the best strategies are in place at all

levels to maximise value creation (using the

Management Agendas and Decision Dialogues)

– Portfolio of Value Centres and Support

Centres

– Value Centre participation strategies

– Value Centre competitive strategies

– Support Centre service and cost strategies

Group CEO

Chairman




The CEO of the Group

Three key responsibilities




2003

The role of the Group

The Centre can create or destroy value: its role needs to be clear: there are four main options

The Portfolio Manager

• Acts as an agent of the financial markets

• Identify, acquire, improve under-valued businesses

• High degree of autonomy for Business Units within financial constraints

• Low central costs

• Strong financial control

• GEC under Weinstock; Berkshire Hathaway; KKR

The Restructurer

• Similar to Portfolio Managers; but the Centre itself delivers the restructuring and drives performance improvement

• Centre has “turnround” staff

• Tomkins

The Synergy Manager

• The whole is greater than the parts

• Shared activities, assets, competences

• Requires BU managers to participate

• And for synergies to be real and achievable

• Tata Tetley; Primedia and About.com

The Parental Developer

• The Centre has competences which it deploys in BUs in order to add value

• Competences could be functional, eg global marketing; or processes, eg managing for shareholder value

• Financial muscle

• Cadbury Schweppes; Lloyds TSB; GE; 3M, Shell




2003

Management information

Requirements in different parts of the organisation

Clear linkage up and down the organisation between performance measures at different levels

Performance targets clearly linked to Group performance aspirations

Performance measures expressed at all levels in ways which are relevant to the decisions managers take at those levels (“balanced scorecard”)

Managers comfortable with the origin and use of the measures and targets

Value Centres need full economic profit information

targets (WV, or time to double value)

budgets (EP)

rewards (EP)

EP for our business plus competitors

EP history, current, forecast

Product Market Units need full economic profit information

targets (WV, or time to double value, or EP)

budgets (EP)

rewards (EP)

Cost Centres need full economic cost information

targets

budgets

rewards

Group CEO

Chairman




corporate value improvement ltd. 1 the art and science of creating superior returns for shareholders...

Documents